Previously we discussed Depreciation as a Tax Advantage to owning real estate (Click HERE to read). The analysis we did to calculate depreciation was pretty basic, but NOT complete if you’re looking to MAXIMIZE this benefit.
Most CPA’s that you would hire to do your taxes at the end of the year will calculate Depreciation the same way we did it HERE. However, a CPA who OWNS REAL ESTATE and KNOWS WHAT HE’S doing will calculate depreciation a little differently. In fact, a CPA who knows the investing game can (in most cases) get you 3 TIMES the Depreciation Benefit, simply by doing the analysis more thoroughly!
In our analysis, we said that Residential Real Estate can be depreciated over 27.5 years. Meaning, that to calculate the annual write-off, you simply subtract the land value from the cost of acquiring and improving the property:
Depreciation (simple analysis) = Acquisition cost, including capitalized improvements – land value
In our example, we assumed (hypothetically) a total acquisition cost of $81,000 and land value of $15,000:
Depreciable Amount = $81,000 – $15,000 = $66,000.
Here’s where it get’s interesting…
OUR CPA (who owns and manages 160+ properties) would do the following to get a MORE REALISTIC value for depreciation:
1. Reduce the non-depreciable land value to a realistic market value
2. Segregate about a third of the property’s acquisition cost to equipment. This can be written off over 7 years about 20% a year. This compares favorably to the normal write off of 27.5 years, about 3 % a year.
So, back to our analysis of the $81,000 property:
Step 1– IS the land really worth $15,000? In most cases NO! What is the Market Value of the Land?? Let’s assume that a vacant lot in that neighborhood would actually SELL in today’s market for $5,000. Then your LAND VALUE should be $5,000 and NOT $15,000 as your CPA would get by looking it up in public records!
Step 2– What portion of the physical property can be divided into equipment vs. building? Houses have equipment such as: HVAC units, water heaters, appliances, even windows! Not just sheet rocks, studs, roofs, and paint. Let’s assume (conservatively) that 30% of the property is equipment. Equipment can be written off over 7 years instead of 27.5 years!! Isn’t this more realistic? Is an AC unit or water heater really gonna last for 27.5 years?
Let’s do our calculation again, using these two steps:
$81,000 (Acquisition cost)
– $5,000 (Land value)
$76,000 (Depreciation amount)
Broken down further…
30% of $76,000 = $22,800 (Equipment)
70% 0f $76,000 = $53,200 (Building)
Depreciation = $22,800/7 + $53,200/27.5 = $3,257.14 + $1,934.54 = $5,191.68
Now, do a comparison of the depreciation calculation from before- using the simple method:
$2,400.00 Old method
$5,191.68 New method
That’s 2-3 times higher! And this is a VERY CONSERVATIVE calculation. We routinely see 3x higher depreciation amounts on our properties after our CPA does the analysis correctly.
The net result is that we can generate a much larger tax deduction that eliminates taxes by increasing deductions without decreasing income for bank purposes.
Please consult with your CPA if you have questions regarding this analysis. Also, if you would like to contact our CPA directly for more information, CONTACT US and we will give you his details.
Hopefully this analysis shows you how important it is to have a CPA that knows the real estate investing game do your taxes. There’s a big difference between having a CPA do your taxes do does NOT own property vs. someone who owns 160+ rentals and is a MAJOR PLAYER.
CONTACT US if you’d like to consult with our CPA on your rental properties.